US Equities Could Keep The Party Going Until 2020: Morgan Stanley

Morgan Stanley says the positive equity cycle just getting into full swing, in a report which contrarians would likely take with a grain of salt

A February 18th report from Morgan Stanley Research argues that it makes no sense to get off the equities merry-go-round right now given how well things have gone and the economic cycle still far from long in the tooth. In fact, according to MS analyst Adam S. Parker and colleagues, the party in US equities could well last all the way until 2020.

Parker et al. explain the virtuous economic cycle is really just beginning. “Capital spending, hiring, inventory, and M&A are all generally somewhat below average to average vs.history. Corporates appear to be sober and planning to grow spending in line with revenue. Few S&P 500 companies will have issues paying the interest-bearing portion of their loans in the next couple of years,and outside of small-and mid-cap energy, very few among the top 1500 US equities will have this problem. Six months ago we wrote that the cycle could last until 2020 and the S&P 500 could near 3000 at cycle end…We think the market will go higher for sometime.”

Potential for more foreign direct investment in US equities

The MS report notes a good deal of discussion with foreign clients regarding breaking out of the current low-yield “bond culture.” Given the seriousness of these conversations, the analysts see the possibility of “incremental foreign direct investment in US equities.”

They also note the dividend yield of the S&P 500 is higher than nearly all government bonds, and that the payout ratios are quite low historically. All of this, together with projected buybacks of more than 2% net of issuance for the S&P 500 this year, is a “strong positive for equities relative to government bonds without even factoring in earnings growth.”

Current Morgan Stanley Research recommendations

Parker and colleagues suggest that a move to financials seems prudent given increasing bond yields. They are adding 2% to Huntington Bancshares, which is rated Overweight by mid-cap banks analyst Ken Zerbe, and screens well on the 3-month alpha model (MOST) and the 24-month return model (BEST).

The MS portfolio is reducing its position in Verizon Communications (a yield play that will look less compelling as rates rise) by 1%, and also lowering their position in Las Vegas Sands by 1% given an analyst downgrade. The analysts note their current sector allocation is overweight consumer discretionary and energy, and underweight consumer staples, industrials, and utilities.